In the past, stock options were a way for companies to reward highly-compensated employees—they’re sometimes referred to as golden handcuffs.
Today, restricted stock has become much more widely used for employees of all levels. If you’ve recently received Restricted Stock Unit grants, it’s important to understand how they work (and how you can maximize your wealth from them!).
Restricted Stock grants are arrangements where a corporation grants their stock to an employee that will EVENTUALLY have access to own in the future as long as they stay with the company over that time span.
These are generally win-win agreements for both the company AND the employee; the employee will be able to cash out (or hold on) to the shares once they are vested, while the company is able to “dangle a carrot” as a reward for staying with the company over that time. It’s also a great way for a company to incentivize key employees to make decisions that will increase the stock price.
One important aspect to equity compensation like RSUs is knowing how you’ll be taxed on the awards. In the case of RSUs, you won’t be taxed when you initially receive the grant—you’ll be taxed at the time of vesting (at the point where you can cash the shares out). Once the RSU is vested, the entire value of those shares become taxable as ordinary income (at your personal income tax rate).
Let’s walk through an example:
· On 1/1/2020: a company grants an employee 300 shares, where 100 shares vest each year over a 3-year period.
o In this example, assume the stock price of the company is at $100.00. So the total value of the grant is $30,000; or $10,000/year.
· On 1/1/2021: the stock price has increased to $110, and the first “tranche” of RSUs vest for the employee.
o The employee gets access to 100 shares of the stock at $110, or $11,000.
o In this case, the employee will be taxed on $11,000 worth of income in 2021.
o Although the tax is unavoidable, the employee isn’t required to sell the shares. This employee could choose to sell all the shares immediately, sell none of the shares, or simply sell enough shares to cover the taxes.
· On 1/1/2022: the stock price has taken a dive, and is now trading at $75.00 on the day the 2nd tranche of RSUs vest.
o The employee receives 100 more shares, and taxable income recognized in 2022 is $7,500.
o If the employee believes the stock price will make a full recovery in the short-run, it’d be wise to hold the stock for a while. This way, they would only owe tax on $7,500 of income, and could give the stock a chance to recover to its original levels.
o Let’s assume the employee was right, and the stock price recovered to $100/share one month later (and sold at that point).
§ They would then owe (ordinary income) tax on $7,500 of the vested shares and owe (Capital Gains) tax on $2,500, netting a total of $10,000.
These plans are fantastic ways for employees to build their wealth and should be taken advantage of. There are several complex planning strategies around stock options and restricted stock, especially for those with a large portion of their net worth tied into a single company’s stock. For those people, I strongly recommend talking with a financial advisor who has an in-depth knowledge of securities. Writing a covered call strategy on the stock to slowly diversify away from being too concentrated into a single stock has proven to be a very effective way to reduce concentration risk in investment portfolios.